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Following the Principles of Islamic Finance

Quarterly Commentary

Q1 2013 · March 31, 2013


Stock markets around the world busied themselves with climbing the wall of worry in the first quarter as investors shrugged off the sequester, brief fears of a U.S. government shutdown, poor Purchasing Managers' Index reports, further reductions in European growth forecasts, an increasingly bellicose North Korea, and a financial meltdown in Cyprus. Overall it was an impressive list to be treated with such sanguinity. Undoubtedly, certain markets have been punished by investors, notably Greece, Italy, and Spain in Western Europe; most of the markets in Eastern Europe including Russia, Poland and the Czech Republic; Brazil and Venezuela in Latin America; and China in Asia.

Nonetheless, most broad market indices have performed well. In North America both the S&P 500 and the Dow Jones Industrial Indices provided double-digit returns in Q1, while Canada and Mexico also gained, the latter assisted by continued peso strengthening. Major European markets such as Germany, France, and the United Kingdom experienced solid returns, with eurozone performance led by Ireland, which continues its return from investment purgatory after years of economic hardship. What separates Ireland from other countries that have suffered similar difficulties? Low taxation, light regulation, and — according to the International Finance Corporation and the World Bank — an Ease of Doing Business Rank of 15 compared to 44 for Spain, 73 for Italy, and 78 for Greece.¹

Painting with a wide brush we can make some generalizations regarding relative performance. Countries featuring more robust government, corporate, and/or personal finances have broadly outperformed those countries struggling with the burden of excessive debt and continued deleveraging. In some regions, especially Southeast Asia, balance sheets are strong on all three levels: government, corporate, and personal. Not coincidentally, we saw double-digit stock market performance in the first quarter from Thailand, the Philippines, and Indonesia — three of our favored emerging markets. Elsewhere in Asia, Japanese corporate and personal finances are solid, while the government labors under the heaviest debt burden as a percentage of GDP to be found among the member countries of the Organisation for Economic Co-operation and Development (OECD). Over the past few months Japan's stock market returns have been boosted by the new government's embrace of monetary and fiscal pump priming, although the Q1 21.4% rise in the broad Tokyo Price Index (TOPIX) in yen terms was a less impressive 10.9% for dollar-based investors due to yen depreciation.


Europe presents a curate's egg. With the exception of Danish mortgages, the prudently financed Northern economies have generally performed acceptably year-to-date. Conversely, everyone knows the story of Spain, Italy, Greece, Cyprus, and the underperforming Southern tier. Meanwhile, here in the United States one hears a constant drumbeat regarding excessive government debt. That may be true, but corporate balance sheets are in rare health and American families have made progress repairing their finances. The drop in debt service as a percentage of disposable income illustrated in the chart above, however, far outstrips the overall reduction in debt — courtesy of low interest rates — which may breed complacency. So far, several years of quantitative easing have not sent interest rates higher, but as America's period of deleveraging nears its end, the policy balance becomes decidedly trickier.

We present these observations because it does not require a great leap of logic to appreciate that what's bad for countries might also be bad for companies. Whether managed, functional, technical, or whatever other adjective the financial mandarins have applied to various national defaults, the fact remains that absent outside assistance Ireland, Greece, Portugal, Spain, and Cyprus or the banking systems therein would have failed to meet their financial obligations. Iceland did not receive assistance and simply reneged on its debts, while Argentina is currently attempting to restructure its obligations.

If so many countries can run into dire financial straits what hope do mere companies have? Well, not being burdened with unfunded mandates or CPI-linked, non-discretionary spending, they have the ability to manage their balance sheets judiciously, or not. At Saturna we strongly favor those companies that do choose to manage their affairs prudently. Borrowing can be addictive, especially in bullish markets when higher leverage may be rewarded with share price appreciation. But when economic conditions deteriorate, high gearing will result in significant business stress, an inability to access capital, and potential going concern risk, each of which tends to have a deleterious effect on share price performance. Meanwhile, the less indebted, positive cash generation companies that are the forte of the Amana Funds provide substantial risk mitigation and potentially morse resilient performance. Using the S&P 500 Index as a proxy for the market in general, the chart below illustrates the comparatively lower leverage of companies held in the Amana funds.


As of March 31, 2013

Ten Largest Contributors Return Contribution
Bristol-Myers Squibb 27.7% 0.56
Genuine Parts 23.6% 0.47
Eli Lilly 16.2% 0.44
General Mills 23.0% 0.43
Honeywell International 19.4% 0.43
Pfizer 16.1% 0.38
Nike Class B 14.8% 0.37
Novartis ADS 16.6% 0.37
Carlisle 15.7% 0.36
PepsiCo 16.4% 0.35
Ten Largest Detractors Return Contribution
Total ADS -6.4% -0.09
BASF ADR -7.6% -0.08
Cenovus Energy -6.8% -0.07
Chunghwa Telecom ADS -3.8% -0.05
United States Steel -12.2% -0.04
Pearson ADS -7.9% -0.04
PPG Industries -0.6% -0.01
Freeport-McMoRan Copper -2.4% -0.01
Tenaris ADS -2.7% -0.01
EnCana -0.6% 0.00
Top Ten Holdings Portfolio Weight
Eli Lilly 2.9%
Nike, Class B 2.7%
Colgate-Palmolive 2.6%
Pfizer 2.5%
W.W. Grainger 2.4%
Canadian National Railway 2.4%
Bristol-Myers Squibb 2.4%
Novartis ADS 2.3%
Honeywell International 2.3%
PepsiCo 2.3%

In Q1 the Amana Income Fund performed broadly in line with its benchmarks, gaining 10.5% for the quarter versus 10.6% for the S&P 500 and 12.3% for the Russell 1000 Value Index. Portfolio sector allocation effect was neutral in the quarter. Negative effects were felt from the small cash position, which averaged just over 2% for the quarter, the absence of financials, and a greater than benchmark exposure to basic materials. These were outweighed by positive allocations to technology (underweight) and significant overexposure to consumer non-cyclical, the best performing S&P 500 sector for the quarter.

Being in the right market segment helps, but we do not tactically allocate our sector exposures. Rather, we focus on identifying companies with the capacity to provide superior long-term returns. Past performance may not guarantee future results but it can provide useful guideposts. Take Genuine Parts, for example. Last year it was a rather desultory performer, but the company features a rock solid balance sheet, good cash generation, and a shareholder-friendly culture of 57 consecutive years of increased dividends. In the first quarter of 2013, its share price nearly doubled the return of the Russell 1000 Growth Index.

Conversely, PPG Industries, a manufacturer of various coatings, underperformed the markets in the first quarter, while in 2012 it gained nearly 60%. Basic materials are currently out of favor, but PPG is a well-managed company with an excellent market position and a history of demonstrated pricing power.


As of March 31, 2013

Ten Largest Contributors Return Contribution
Amgen 19.4% 0.51
Church & Dwight 21.2% 0.42
Hewlett-Packard 68.4% 0.42
Infosys ADS 27.5% 0.38
Norfolk Southern 25.6% 0.37
Clorox 21.9% 0.35
Adobe Systems 15.5% 0.35
Johnson & Johnson 17.2% 0.33
Google 11.9% 0.33
Novartis ADS 16.6% 0.31
Ten Largest Detractors Return Contribution
Apple -16.5% -0.82
Akamai Technologies -13.7% -0.26
PetSmart -9.1% -0.20
Monster Beverage -9.7% -0.18
Anglo American ADR -15.9% -0.16
America Movil ADR -9.4% -0.11
Barrick Gold -15.6% -0.10
Suncor Energy -8.6% -0.09
Harris -4.6% -0.07
Oracle -2.9% -0.07
Top Ten Holdings Portfolio Weight
Apple 4.0%
Google 3.0%
Amgen 3.0%
Intuit 2.7%
Adobe Systems 2.5%
Qualcomm 2.4%
IBM 2.4%
Church & Dwight 2.3%
Trimble Navigation 2.3%
Johnson & Johnson 2.2%

The first quarter was challenging for the Amana Growth Fund, which gained 6.0% versus 9.5% for the Russell 1000 Growth Index. While we have reduced the cash position below 5%, it still presented a drag on performance. Apart from cash, a handful of positions caused problems in the first quarter. Among the more significant was Monster Beverage, which suffered from bad press concerning the potential negative health effects of energy drinks. We consider the issue to be overblown and the stock has rallied sharply. Our other consumer staples stocks all provided positive contributions led by Clorox. Basic materials were another area of weakness as producers of gold and other hard commodities were punished. Financial writers are dusting off their gold obituaries, a phenomenon repeated several times over the past ten years, but viewing the continued debasement of fiat currencies — with Japan now wholeheartedly joining the monetization party — we see value in maintaining our positions.

More positively, our technology, health care, and industrials positions performed well in the quarter with the former led by Adobe, IBM and Intuit and the latter by Emcor and Lincoln Electric, which we recently visited. In the health care space, Eli Lilly, Amgen, and Novartis all performed well.



As of March 31, 2013

Ten Largest Contributors Return Contribution
Bangkok Dusit Medical Services 53.3% 1.15
MercadoLibre 23.1% 0.60
Telekomunikasi Indonesia ADS 22.0% 0.58
Ford Otomotiv Sanayi 21.2% 0.47
Infosys ADS 27.5% 0.44
Mindray Medical International ADS 23.8% 0.36
Mead Johnson Nutrition, Class A 18.1% 0.33
Kalbe Farma 16.0% 0.29
Western Digital 18.9% 0.26
VF 11.7% 0.25
Ten Largest Detractors Return Contribution
Impala Platinum ADR -26.7% -0.40
Alamos Gold -21.7% -0.40
Gold Fields ADS -27.2% -0.38
Clicks Group -15.9% -0.34
Anglo American ADR -15.9% -0.29
Li & Fung -21.9% -0.23
Vale ADS -17.5% -0.22
MTN Group -13.3% -0.21
CNOOC ADS -13.0% -0.20
Baidu.com ADS -12.6% -0.20
Top Ten Holdings Portfolio Weight
Bangkok Dusit Medical Services 3.1%
Telekomunikasi Indonesia ADS 3.0%
MercadoLibre 3.0%
Ford Otomotiv Sanayi 2.6%
Aspen Pharmacare Holdings 2.3%
M. Dias Branco 2.3%
VF 2.3%
Mead Johnson Nutrition, Class A 2.1%
Kalbe Farma 2.0%
LATAM Airlines ADS 2.0%

When considering the developing world, thoughts often turn to the BRIC countries: Brazil, Russia, India, and China. Unfortunately for emerging markets investors, the group has performed relatively poorly for some time. We have had concerns regarding the investment environments of the quartet. In a nutshell, Russia suffers from poor corporate and political governance, India from stifling bureaucracy, Brazil from expanding statist policies, and China from politically directed investment that misprices the cost of capital. To be sure, there are excellent companies in each, and we have investments in all but Russia. The market opportunity in those countries also ranges from impressive to enormous. Regardless, we find the overall investment climate less attractive than in other regions/countries such as ASEAN, Turkey, and Mexico. As a result, we sometimes choose to gain exposure to the market opportunity through investing in companies that are active but not domiciled in the BRIC countries.

In the first quarter the Amana Developing World Fund benefited from lower BRIC exposure, gaining 2.2% versus a 1.6% decline in the MSCI Emerging Markets Index. Our overall sector allocation was slightly negative as the Fund's lack of exposure to financials and an overweight position in basic materials balanced against the positives of an overweight exposure to consumer staples and underweight positioning in energy.

The real story of the quarter, however, was strong stock selection across a number of sectors, including communications, consumer cyclical and non-cyclical, and technology. Some of our largest positions such as Bangkok Dusit Medical, Telekomunikasi Indonesia, MercadoLibre, and Ford Otomotive Sanayi enjoyed strong performance in the quarter helping to boost returns. The only sector to suffer significantly from negative selection was basic materials, within which our precious metals mining positions were a drag on performance. Selection in energy was also negative, although the impact was mitigated by low exposure to the group.



¹ International Finance Corporation, World Bank Group Economy Rankings, June 2012: ww.doingbusiness.org/rankings

As of March 31, 2013

Average Annual Total Returns (Before Taxes) 10 Year 5 Year 3 Year 1 Year Expense Ratio
Amana Income 12.65% 6.42% 10.52% 14.00% 1.20%
S&P 500 Index 8.53% 5.82% 12.70% 13.96% n/a
Russell 1000 Value Index 9.16% 4.85% 12.79% 18.85% n/a
Amana Growth 12.62% 6.16% 8.59% 5.39% 1.13%
S&P 500 Index 8.53% 5.82% 12.70% 13.96% n/a
Russell 1000 Growth Index 8.66% 7.31% 13.09% 10.08% n/a
Amana Developing World Fund¹ N/A N/A 2.00% 2.83% 1.63%
MSCI Emerging Markets Index 17.05% 1.09% 3.28% 1.96% n/a

Expense ratios shown are as of the Funds' Prospectus dated September 14, 2012.

30-Day Yield Div Yld P/E P/CF P/B Total Debt to Market Cap
Amana Income 1.5 2.7 15.9 10.7 3.3 18.4%
Amana Growth 0.4 1.8 18.1 11.4 3.3 15.1%
Amana Developing World 0.2 2.5 17.7 11.3 3.0 16.7%
S&P 500 n/a 2.1 15.5 9.4 2.3 55.2%
Div Yld: Dividend Yield     P/E: Price-to-Earnings Ratio     P/CF: Price-to-Cash Flow Ratio     P/B: Price-to-Book Ratio

Performance data quoted represents past performance, is before any taxes payable by shareowners, and is no guarantee of future results. Current performance may be higher or lower than that stated herein. Performance current to the most recent month-end is available by calling toll-free 888/73-AMANA or visiting our Month-end Returns page. Average annual total returns are historical and include change in share value as well as reinvestment of dividends and capital gains, if any. The investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Shares of a Fund may only be offered for sale through the Fund's prospectus or summary prospectus.

A Fund's 30-Day Yield is calculated by dividing the net invest income per share during the preceding 30 days by the net asset value per share on the last day of the period. The 30-Day Yield provides an estimate of a Fund's investment income rate, but may not equal the actual income distribution rate.

The S&P 500 is an index comprised of 500 widely held common stocks considered to be representative of the U.S. stock market in general. The Russell 1000 Value Index is a widely recognized index of large-cap value stocks. The Russell 1000 Growth index is a widely recognized index of large-cap growth stocks. The MSCI Emerging Markets Index, produced by Morgan Stanley Capital International, measures equity market performance in over 20 emerging market countries. Investors cannot invest directly in the indices.

¹ The Amana Developing World Fund began operations September 28, 2009.

A Few Words About Risk

A Fund's performance depends primarily on what happens in the stock market. The market's behavior is often volatile, particularly in the short-term and in periods of unusual market occurrences. Because of this, the value of your investment will rise and fall, and you could lose money. For performance current to the most recent month-end, please ask your representative, visit our Month-end Returns page, or call us toll-free at 888/73-AMANA (888-732-6262).

By diversifying its investments, each Fund seeks to reduce the risk of owning only a few securities. Diversification does not assure a profit or protect against a loss in a declining market. The Growth Fund typically invests in smaller and less seasoned companies than the Income Fund, which may lead to greater variability in the Growth Fund's returns. Growth stocks, which can be priced on future expectations rather than current results, may decline substantially when expectations are not met or general market conditions weaken.

The Funds may invest in non-U.S. companies and in foreign markets. Investing in foreign securities involves risks not typically associated directly with investing in U.S. securities. These risks include fluctuations in exchange rates of foreign currencies; less public information with respect to issuers of securities; less governmental supervision of exchanges, issuers, and brokers; and lack of uniform accounting, auditing, and financial reporting standards. There is also a risk of adverse political, social or diplomatic developments that affect investment in foreign countries.

Islamic principles restrict the Funds' ability to invest in certain stocks and market sectors, such as financial companies and fixed-income securities. This limits opportunities and may increase risk.

Important Disclaimers and Disclosure

This report is intended only for the information of the reader, and is not to be used for or considered as an offer or the solicitation of an offer to sell or buy any securities or other financial instruments of any kind, including without limitation, any mutual fund or other product offered, sponsored, created, or managed by Saturna Capital Corporation or its subsidiaries or affiliates ("Saturna"). This report is not intended for distribution to, or use by, any person or entity who is a citizen or resident of, or located in, any locality, state, country, or other jurisdiction in which such distribution, publication, availability, or use would be contrary to law or regulation or which would subject Saturna to any registration or licensing requirement within such jurisdiction.

This document should not be considered as providing investment advice or services, or any service offered by Saturna. Saturna may not have taken any steps to ensure that the securities referred to in this report are suitable for any particular investor. Saturna will not treat recipients as its customers by virtue of their reading or receiving the report.

Nothing in this report constitutes investment, legal, accounting or tax advice or a representation that any investment or strategy is suitable or appropriate to a particular investor's circumstances or otherwise constitutes a personal recommendation to any investor. Saturna does not offer advice on the tax consequences of any investment.

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The information in this report was obtained from sources Saturna believes to be reliable and Saturna believes the information and opinions in the material are accurate and complete as of the date of this material. However, information and opinions contained herein will change over time and without notice. Saturna has no obligation to update or amend any information or opinions at any time. Saturna makes no representations as to the accuracy or completeness of this material, nor does it have any responsibility to ensure that any other materials, including any containing materially different information, are brought to the attention of any recipient of this report.

Under no circumstances shall Saturna, its employees, or any affiliate, be responsible for any investment decision by any recipient. This material is distributed on condition that it will not form the sole basis for any investment decision by any recipient. Any recipient who is not a market professional or institutional investor should seek the advice of an independent financial advisor prior to making any investment based on this report or for any necessary explanation of its contents.

Saturna does not provide tax, legal or accounting advice. Investors should consult their own tax, legal and accounting advisers before engaging in any transaction. In compliance with IRS requirements, recipients are notified that any discussion of U.S. federal tax issues contained or referred to herein is not intended or written to be used for the purpose of (A) avoiding penalties that may be imposed under the Internal Revenue Code; nor (B) promoting, marketing or recommending to another party any transaction or matter discussed herein.

Past performance does not imply or guarantee future performance, and no representation or warranty, express or implied is made regarding future performance. The price, and value of, and income from, any of the securities or financial instruments mentioned in this report can fall as well as rise. The value of foreign securities and financial instruments is subject to exchange rate fluctuation that may have a positive or adverse effect on the price or income of such securities or financial instruments. Investors in securities such as ADRs — the values of which are influenced by currency volatility — effectively assume this risk.

Dividend yield: The amount of cash per share a company pays out yearly to its shareowners as a percentage of the current price per share. A company with a stock price of $25 per share paying a dividend of $1 per share each year would have a dividend yield of 4% (1 ÷ 25 = 0.04 x 100 = 4%).

Price-to-earnings ratio (P/E): The share price of a company's stock divided by its reported earnings per share. The P/E ratio is also referred to as the "multiple" of a company's earnings.

Price-to-cash flow ratio (P/CF): The share price of a company's stock divided by its reported operating cash flow per share.

Price-to-book ratio (P/B): The share price of a company's stock divided by the reported value of the company's tangible assets per share. The P/B ratio is also referred to as the "price-equity" ratio.